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Thursday, 25th April 2024 |
| Is tax on your board’s agenda? |
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| Liam Lynch comments on the increasing stature of tax in the corporate governance arena and on what this really means for group tax functions. |
Changes in tax function
Historically the tax function constituted a tiny component of the accounting and finance department in most organisations, assuming one existed at all. Its primary role? To provide a corporate tax figure to complete the financial accounts and ensure that corporate tax compliance was taken care of, quietly and carefully.
This has changed dramatically in recent years. Due in no small part to a number of corporate scandals, such as Enron, Parmalat etc, tax related matters have started to interest journalists and hit the headlines. Tax management has become the target of sometimes emotional and, arguably, misguided comment about whether companies pay their fair share.
Such developments have forced group tax functions out of their old habitat to join the ranks of management and to seek more formal recognition for their policies and requirements right up to board level.
Increased demands
Tax departments now face increased demands from both internal and external stakeholders. In the largest organisations, it is fully accepted that the financial and reputational risks around tax make it a boardroom matter. The concept of performance measurement based on shareholder value, and therefore post-tax results has become more commonplace.
Awareness has increased of the potential damage that can be done to reputations if a company is perceived to engage in what some might construe as ‘unacceptable’ tax planning - the company may be characterised as ‘high risk’ by tax authorities and branded ‘unethical’ in the media.
At tax authority level there appears to be a trend towards a risk-based approach to identifying non-compliant taxpayers and some larger authorities (such as US, Australia etc) see a lack of board level involvement in setting the tax agenda as tantamount to bad management, if not negligence.
What this means for the tax function
In considering a tax risk policy, group tax functions must grapple with questions such as whether to measure business line performance using post-tax or pre-tax measures. The former makes tax cost a reality for front line managers. On the other hand, the use of pre-tax measures avoids encouragement of certain inappropriate behaviour, such as competitive tax planning between different parts of the business, that benefits the individual business unit at the expense of the business as a whole.
In any organisation, the tax function will draw up the detailed implementation rules on tax risk policy but decisions regarding the company’s attitude to tax and the management of associated risks can only be taken at board level. The challenge, of course, is to communicate the relevant parameters effectively to non tax professionals to give them adequate understanding to reach informed decisions.
The tax function must then put appropriate procedures in place to implement the policy, ensuring appropriate sign-offs are obtained for tax planning and structuring activity, that appropriate advice is taken, that issues are communicated quickly to avoid surprises and so on. Such risk policies need to cover the whole array of taxes - corporate tax, indirect taxes, transactional taxes etc When one considers that such work comes at a time of ever-increasing compliance and information reporting requirements from tax authorities, it is no surprise that this is putting significant strain on tax functions.
The ‘moral’ agenda
Alongside these developments, a worrying tendency seems to have emerged among external stakeholders to make ‘moral’ judgements about tax planning and to expect companies to manage their tax affairs in a ‘moral’ way. The ‘fairness’ of corporations’ tax policy is frequently questioned by tax authorities, pressure groups and media.
Let’s be clear about this. Tax is a cost to business. As with any other cost, the board members owe their shareholders a duty to manage that cost by the legal means afforded to them. Where a company’s tax philosophy is heavily influenced by a duty to shareholders, the focus should be on responsible management of tax cost. Again the starting point should be board level decisions on how the risk needs to be managed.
It seems to have become fashionable to use terms such as ‘aggressive tax planning’ and ‘unacceptable tax minimisation’ synonymously with ‘tax avoidance’, whilst arguing that such practices demonstrate a lack of morality in tax matters. However there is no agreement on what constitutes morality either within or outside the sphere of tax. We cannot therefore have recourse to such a term in determining whether planning of tax affairs has crossed some illusory line. It is in the interests of some parties that lines are blurred in the perception of the difference between legal tax avoidance and illegal tax evasion. However, we must rely on the rule of law to protect the rights of both taxpayers and exchequers alike. Otherwise we will have to deal with such questions as to whether we should pay tax if it funds something we consider immoral. That is surely something we wish to avoid.
That said, in order to manage reputational risk, companies must reconcile their obligations to shareholders, to manage the bottom line, with public perceptions on the ethical and moral nature of tax planning or tax motivated transactions. Interestingly a survey carried out by KPMG International in 2005 for the purposes of a paper, Tax in the Boardroom, showed very low appetites for any level of reputational risk. It seems boards recognise that while certain tax planning strategies may contribute to the bottom line and create shareholder value in the short term, they may have the potential to destroy value in the long term if a company’s reputation suffers. To this end, many large groups are developing reputational risk committees of one type or another to opine centrally on whether certain transactions or planning initiatives fit within the group’s acceptable risk profile. They usually have a clear mandate from board level or may even consist of board members.
The reality
KPMG published a discussion paper on The Governance of Tax earlier this year which confirmed that tax governance is rising up the board agenda. Progress has been made towards recognising tax as a key issue for boards since the 2005 publication, Tax in the Boardroom. However, as tax is becoming ever more complex, many companies still have a gap between the required level of understanding, and involvement at board level, and that which is needed to ensure that appropriate tax strategy is put in place, and that tax departments are not left exposed.
Another KPMG report, The Rising Tide, published earlier this year, presented survey results which indicated that less than half (48%) of companies have a formal tax risk management strategy, although experience would suggest that tax issues are frequently addressed at board level irrespective of the absence of formal procedures. Even though increased focus on this area has only emerged relatively recently, the majority of those surveyed did report greater scrutiny from CFOs and audit committees, while at the same time having to cope with increased compliance requirements.
The survey gave some insight into increased pressures faced by tax departments worldwide and the fact that many are struggling to communicate their need for additional resource. Most tax departments surveyed still spent the majority of their time on tax return compliance but believed they could offer more value elsewhere such as in the provision of accurate and timely financial reporting, assessment of tax risk, management of tax authority audits, offering strategic advice to the business etc.
Conclusion
In many ways, the corporate scandals which raised the profile of tax risk, and that of the teams who manage it, only accorded tax a level of prominence which it has always warranted. Tax needs to be on the agenda for the boards of companies because it is increasingly expected that that is where the policy in this regard is set. At the same time, Revenue authorities need to respect the fact that tax is a cost to business and must be managed as such. The tax department’s key responsibilities are to manage that cost, ensure absolute compliance with the tax code and manage the inherent tax risks that exist in all organisations. |
Liam Lynch is a Tax Partner at KPMG. For copies of discussion papers and surveys conducted by KPMG mentioned above, please e-mail taxmonitor@kpmg.ie.
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